Arberg v. Commissioner of Internal Revenue, No. 15376-05 (U.S.T.C. 8/27/2007), 15376-05.
| Decision Date | 27 August 2007 |
| Docket Number | No. 15376-05.,15376-05. |
| Parties | LEE B. ARBERG AND MELISSA A. QUINN, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
Prior to 1999, a brokerage account at E Trade Securities, Inc., was established in the name of P-W. For 1999, P-W filed a separate return reporting capital gain income from activity in the E Trade account. For 2000, Ps contend that losses generated in the E Trade account are entitled to ordinary income treatment by reason of a business of P-H as a trader in securities and that various expenses should be allowed as deductions of the securities trading business and/or a consulting business of P-H.
Held: Gains and losses in the E Trade account must be attributed to P-W and are capital in nature.
Held, further, Ps are not entitled to expense deductions in excess of those allowed by R.
Held, further, Ps are liable for the accuracy-related penalty pursuant to sec. 6662, I.R.C., for 2000.
Roger D. Lorence, for petitioners.
Stephen R. Takeuchi, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
Respondent determined a Federal income tax deficiency for petitioners' 2000 taxable year in the amount of $167,221 and a penalty pursuant to section 6662(a) in the amount of $33,444.1 After concessions, the principal issues for decision are:
(1) Whether petitioners are entitled to report claimed gains and losses in ordinary income on account of an alleged business of petitioner Lee B. Arberg (Mr. Arberg) as a trader in securities within the meaning of section 475(f)(1);
(2) whether petitioners are entitled to deduct various business expenses claimed in connection with the securities trading and/or a consulting business of Mr. Arberg; and
(3) whether petitioners are liable for the section 6662(a) accuracy-related penalty for 2000.
Certain additional adjustments; e.g., to itemized deductions, are computational in nature and will be resolved by concessions made and our holdings on the foregoing issues.
Some of the facts have been stipulated and are so found. The stipulations of the parties, with accompanying exhibits, are incorporated herein by this reference.2 At the time the petition was filed in this case, Mr. Arberg resided in Florida and petitioner Melissa A. Quinn (Ms. Quinn) resided in Georgia.
Mr. Arberg was born in 1968 and graduated from Princeton University in 1990 with a major in history. Upon graduation, he was employed by the Cummins Engine Company in Columbus, Indiana. He worked in the company's mergers and acquisitions division, focusing on financial and valuation analysis. After approximately 2 years, Mr. Arberg went to work for Hemisphere Trading Company, an investment adviser based in Memphis,
Tennessee, and he remained there for roughly 5 years. At Hemisphere Trading Company, Mr. Arberg was in charge of portfolio management trading, and his duties included both executing trades and supervising trades executed by other employees.
During the mid- to late-1990s, Mr. Arberg also served on the board of directors of the company SI Diamond Technology, Inc., and provided consulting services to the entity. The consulting services were directed toward conducting a valuation relating to a proposed merger and acquisition transaction. Mr. Arberg's compensation for that work consisted primarily of stock options, which Mr. Arberg apparently sold at a gain in the late 1990s. Sporadic additional services may have been provided to SI Diamond Technology, Inc., or a successor entity in the early 2000s.
Following his work at Hemisphere Trading Company, Mr. Arberg's next principal employment was for Lasertron, a subsidiary of Oak Industries, Inc. Lasertron was involved in the fiber optics and photonics business, and Mr. Arberg was engaged in 1999 to provide a valuation of that business, again with a view towards a potential merger or acquisition transaction. The work culminated with the signing in November of 1999, and the closing in January of 2000, of an agreement for the sale of Oak Industries, Inc., and its Lasertron subsidiary to Corning, Inc., creating a division referred to as Corning Lasertron. Mr. Arberg's work for Lasertron ended with the closing of the
sale. He was compensated with salary and stock options, which options he exercised in early 2000.
Ms. Quinn was born in 1969 and graduated from the University of Delaware in 1987 with a major in economics. She then went to work for Lehman Brothers, Inc., in New York City. She was employed as an institutional trader, executing at the institutional desk trades of large blocks of stock for major accounts. Mr. Arberg and Ms. Quinn met through her role as a "sell side" trader and his as a "buy side" client of Lehman Brothers, Inc., during his employment at Hemisphere Trading Company. Ms. Quinn took a position as an institutional trader with Salomon Smith Barney, Inc., in Atlanta, Georgia, in 1997 or 1998. Mr. Arberg and Ms. Quinn were married in Atlanta in May of 1998.
Mr. Arberg began buying and selling securities for his own account in 1992, and he continued that activity through at least 2000. Petitioners testified that by 1998 Mr. Arberg had begun to invest in extensive computer and telecommunications equipment and access to specialized stock information services, such as those referred to as the Bloomberg and InstaNet systems. Mr. Arberg concentrated his activities in industry sectors with which he had experience, particularly those involving telecommunications and fiber optics. He described his strategy as follows:
A I would, without a doubt, consider myself a position trader, where you're taking the position
versus someone who is trying to trade for TICS [ticks?]. When I say TICS, I mean, if a stock is trading at 10 1/8, a TIC trader would buy a [sic] 10 and try to sell it at 10 1/4, make 25 cents, and say, thank you and goodbye. I mean, that's something that I felt I was ever [sic] good at. I understand the fundamentals of a company. So I did position trading. You know, position trading is probably 60 to 70 percent of the trading done on Wall Street.
Q What was the average length of time that you held each position?
A Well, the average length of time can't be predetermined. Whereas a TIC trader would say, Okay, I'm buying at 10, as soon as it hits 10-1/4, I'm out and gone; and if it trades at 9-7/8, I'm out, because you're playing for the TICs. A position trader would say that this, and relative to other groups on my spreadsheet, it's undervalued or overvalued. Because it's undervalued, it should at least migrate towards the mean. That's what I'm trying to wait for. I don't know how long that migration may be. At the same time, you've got to be careful of your losses.
I mean, I can't say, you know what, it's 20 percent undervalued, but this is the way we were paying our mortgage payments. So I can think all day long that it's 20 percent undervalued , but if it goes to 50 percent undervalued, we'd be mowing lawns.
Q The original 1040 for 2000 doesn't show any long term gain or loss. Did you ever hold any positions in 1998 for long term gain or loss?
* * * * * * *
A Not on purpose. When I say, not on purpose, that would not be the reason. It would happen because I would have a spreadsheet of names, and on those names, I'd find something that was 20 to 30 percent undervalued. If it's creeping up and it's now 10 percent undervalued compared to the group, there's no necessary reason for me to sell it just to sell it. I'd sell it just because it went above that median valuation.
A It would be the same situation.
By 1998, Mr. Arberg was conducting securities trades through accounts held in his name at Charles Schwab and/or Salomon Smith Barney. At some point during 1998 or 1999 not clear from the record, a brokerage account in the name of Ms. Quinn was opened at E Trade Securities, Inc. Because of employee trading restrictions imposed as a result of her position with Salomon Smith Barney, Ms. Quinn was required to, and did, obtain the permission of her superior to establish the E Trade account. According to petitioners, a principal source of funding for the E Trade account was compensation Mr. Arberg received from his consulting work.
Petitioners filed separate Federal income tax returns for 1998 and 1999. They then filed a joint Form 1040, U.S. Individual Income Tax Return, for 2000. For 1998, Mr. Arberg reported wage income of $76,766 and included with his return a Schedule C, Profit or Loss From Business, for a business characterized as "Mark to Market Trading".3 The Schedule C
reflected gross income of $49,777, expenses of $176,452, and a resultant net loss of $126,675. The expenses comprised mortgage interest of $5,799, office expenses of $3,240, travel of $6,147, meals and entertainment of $1,421, utilities of $3,987, and other expenses of $155,858. The other expenses were explained as follows:
Tax payer elects to be a mark to market trader. Code Section 475 (f) (1) (A) Losses on mark to market trades and holdings at year end-see attached schedule.
The attached schedule listed 17 securities lots, each with a date acquired and date sold between January 7 and September 18, 1998, and reflected a net loss on the transactions of $155,858.29. Appended below the listing was the statement: "As of 12/31/98, there were no open positions to mark to market." The transactions were conducted through the account held in Mr. Arberg's name at Charles Schwab. A Schedule D, Capital Gains and Losses, was also attached to the return and repeated in an annotation that "Tax Payer elects to be a mark to market trader under code section 475 (f)(1)(A)".
For 1999, Mr. Arberg again filed a separate return showing wage income ($84,114 (rounded) from Lasertron) and also attaching a...
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